The Startup India Event organized by the Government last month was extremely well received by the entrepreneurial community. The event culminated in the unveiling of the Startup India Action Plan (“SAP”) by the Prime Minister. As expected, there were several interesting proposals aimed at promoting the growth and development of startups in India. This blog looks into some of the proposals that garnered much attention and analyses whether these are adequate to make the startups to “stand up”.

Definition

The Government has rightly sought to clearly outline the beneficiaries of the SAP by defining the term “startup”. The SAP has defined a startup as an Indian entity that is not more than 5 years old and having an annual turnover of not more than INR 250 million in the preceding financial year. Further, such entity should be working towards innovation, development, deployment or commercialization of new products, processes or services (“Objectives”); and must be driven by technology or intellectual property. In addition, such entity should not have been formed by the restructuring of a business already in existence.

Defining a startup is not an easy task and for many entrepreneurs, startup is merely “a state of mind” which cannot be defined. The Government should be complimented for its efforts in outlining the contours of a startup well. While the definition adequately captures most characteristics of a startup, the condition of it being driven by technology or intellectual property could exclude certain enterprises from being classified as a startup. The idea of the SAP should be to incentivize ventures that benefit the nation by working towards the stated Objectives, and it being driven by technology or intellectual property need not be the determining factors. Accordingly, it would be beneficial if the final policy drops this requirement from the definition so that businesses achieving the stated Objectives, for instance rural health and education, are not kept out of the policy for them not being driven technology or intellectual property.

Ease of Doing Business

The SAP has proposed the rolling out of a mobile app and portal through which startups could be registered with different agencies of the Government and also make various compliance related filings. This could drastically reduce the time period for registering a startup in India, which at present takes up to 3 weeks. It would also be helpful if a nodal authority is constituted by the Government to streamline the entire process of seeking approvals and registrations by the startups.

Another positive step towards reducing the regulatory burden on startups is the proposal to allow startups to self-certify their compliance with respect to certain specified labour and

environmental laws. Further, no inspections would be conducted on startups with respect to labour laws in the first 3 years unless there is a credible complaint regarding their violation. The above measures, apart from permitting the entrepreneurs to focus on their core business, would shield the startups from corruption, which was pointed out as the biggest grouse of the entrepreneurs in a recent survey. While this is indeed welcome, there is a fear that the lack of threat of prosecution could lead to non-compliance of the labour and environmental norms by startups, and adequate safeguards must be implemented to avoid such a scenario.

The SAP also proposes to simplify the mechanism for winding up of startups by incorporating special provisions in the Insolvency and Bankruptcy Bill, 2015 (“IB Bill”). Given that a large number of startups fail, an easy winding up process would reduce the burden on entrepreneurs, and enable them move on to a new venture without getting bogged down by the long-drawn winding up process. The IB Bill would, however, have to go through the expansive debates in both houses of the Parliament and could take considerable time before it is made into law. Hence, it would be beneficial if a fast track scheme for winding up of startups is announced as part of a special scheme by the Government in the interim.

Tax Benefits

The loudest cheers during the event were reserved for the tax soaps proposed by the Government. With the idea of enhancing the working capital for startups, it was proposed that the profits of startups would not be taxed for a period of 3 years. On further reflection, however, this measure may not alter the landscape for startups too much as most of them may not see taxable profits in their initial years. In addition, the policy does not clearly state whether the exemption is available for the first 3 years from incorporation or for the first 3 years of profitability. Even if one were to assume that it is the latter, an entity ceases to be a startup after 5 years of incorporation, and considering that even some of the poster boys of Indian startup ecosystem are yet to see any profits, the tax exemption may not move the needle much for most startups.

One would feel that the startups would have been better served had the Government provided them with exemption/incentives under indirect taxes during the first 3 years of incorporation. Startups often have to spent considerable amounts towards indirect taxes, such as service tax and customs duties, and any reduction in such tax outgo would definitely augur well for them.

The SAP also proposes to extend the current tax exemption for the consideration received by a startup in excess of the fair market value of shares when its shares are issued to a venture capital fund, in case of issuance to incubators as well. While this step would benefit startups that are backed by incubators, HNIs are the prime source of early stage funding for most startups and the tax exemption should have been extended to them as well.

Attracting Investments

The Government also announced several measures aimed at attracting further capital towards startups. A capital gains tax exemption has been proposed for people who invest such taxable gains in fund of funds recognized by the Government. In addition, the existing exemption for capital gains tax (in relation to gains from transfer of residential property) in case of investment in small and medium enterprises in the manufacturing sector is proposed to be extended to all startups.

Further, to augment the funding channels for startups, the Government has proposed to establish a fund of funds with a corpus of INR 100,000 million. Without getting into the debate of whether the Government is in the right in utilizing tax payers’ money for funding start-ups, one point I would like to make is that the Government should come up with a transparent policy for identifying the startups that would be eligible for such Government funding. Perhaps it would be a good idea for the Government to fund social venture/impact funds that back businesses serving underserved consumers. These social ventures are necessary to address some of the most significant problems of the Indian society. However, they often fail to garner the attention of institutional investors, particularly in their later stages, and the fund of funds of the Government could offer much needed fillip.

The SAP also has several other proposals like easy and fast track registration of intellectual property, enabling startups to participate in Government tenders, offering credit guarantees, creation of incubators, innovation centers, and research parks, etc.

While the SAP addresses several key concerns of the startups, at several instances, it stops short from being a true game changer. Nevertheless, the Government should be lauded for the positive intent showcased through the SAP and it is hoped that the Government is able to translate this intent into real action.